7. What is Budgeting?

You must have planned for a vacation in your life. What are the key questions you consider before going on a vacation? Let’s see:

  • How many clothes will you take?
  • Where will you stay?
  • What will you eat?
  • How much should you spend on souvenirs?

Well, these and a lot of other questions are part of your ‘plan’ for relaxing and taking sometime off from work. Similarly, ‘budgeting’ in the Finance world is the process of making a sound plan to spend your money. Imagine making a plan to go on a vacation but forgetting to make a plan for your money! Budgeting allows you to plan in advance how much money you would need to save in order to go on a vacation, buy a new car, buy your dream house or get married. In this context, budgeting can also be defined as a process to allocate expected income to expected expenses and savings.

6.1. How to Budget?

Follow these simple steps today to be able to save enough for fulfilling your dreams in the future:

  • Set realistic goals: A goal can be anything from purchasing your dream house or paying for your child’s education to going on a vacation or starting your own business. Grab a pen and a paper and jot down your goals.
  • Separate income and expenses: Income includes your salary, commission and any other source of income such as rent received from a property you own. Expenses include wages to your workers, rent payment, utility bills, food, fuel or credit card payments. It is crucial to differentiate between needs and wants in this step. Ask yourself: Do I really need to buy this item? Can I buy a less expensive item that may provide the same value?
  • Make your personal budget: Let’s look at an example of a family of two people – Ali and Aisha. Ali works at a bank and earns Rs. 30,000 per month after paying taxes. Aisha works as a school teacher and earns Rs. 25,000 after tax. Ali goes to work on a bike and Aisha uses public transport in Karachi. Following is a snapshot of this family’s personal budget:
Monthly Income In PKR
Ali 30,000
Aisha 25,000
Total Income 55,000
Planned Expenses In PKR
Rent of their apartment 3000
Fuel for Ali’s bike 3000
Transport cost for Aisha 1000
Life Insurance for surviving spouse 1000
Groceries 9000
Utility bills 3000
Total Planned Expenses 20,000
Unplanned Expenses In PKR
Repair/Maintenance of Ali’s bike 3000
Repairs in the apartment 4000
Total Unplanned Expenses 7000
Leftover Income or Savings 28,000

Ali and Aisha can save Rs. 28,000 every month after accounting for both planned and unplanned expenses. They can either utilize this money to buy something they want today or save and invest it to be able to grow it to an amount that is sufficient for fulfilling their targeted goal.

6.2. Key risks:

You need to strike a balance between savings and spending. What happens if you don’t? Consider the following situations:

  • You spend more than your income and end up borrowing money from your friend or a bank. If you borrow it from a bank, you have just increased your future spending by the amount of debt repayment!
  • You spend too less and end up compromising on your standard of living.
  • You save too less and you are unable to buy your dream house or pay for your child’s education.

The bottom line is to understand the importance of budgeting at an early age. This can help you manage your both your personal and business finances.